By: AnnaMarie Mock, CFP®
Equity compensation is a powerful tool for pharmaceutical executives to enhance their financial health and secure a stake in their company's long-term growth. As a Certified Financial Planner™ at Highland Financial Advisors, AnnaMarie Mock delves into the intricacies of equity compensation, providing valuable insights and strategies. In this video, we explore the various components of equity compensation, including stock options and grants, to help you make informed decisions and optimize your financial plan.
Introduction
[Music] Hi, my name is AnnaMarie Mock, and I'm a Certified Financial Planner™ at Highland Financial Advisors. If you like my content, please click on subscribe below, and you'll get notified of any new videos as they're released.
Discussion on Financial Health
Today, we will continue our discussion on step two of how pharmaceutical executives can take control of their overall financial health. We will also explore human capital by looking at the third component, equity compensation.
What is Equity Compensation?
Equity compensation is non-cash pay in the form of stock options and grants. This isn't just a perk; it's a stake in the company's long-term growth. Understanding equity compensation is crucial because of the timing and unique tax consequences that can impact someone's long-term wealth creation. It also helps to make informed decisions rather than reacting to impulses or gut feelings.
Case Study: Understanding Equity Compensation Components
So, today, we will jump into the case study to learn about some equity compensation components.
John's Scenario
John is the director of clinical research at a large pharmaceutical company that offers stock options as part of their general compensation package. Once he signs on, John is granted or issued stock options at a strike price of $10. The strike price is the price at which he can purchase these options in the future.
Vesting Schedule
John's options also come with a 4-year vesting schedule, meaning that the options will vest at 25% over four years. Vesting is very important and can be based on either time or performance milestones. If you leave the company before they vest, your options are forfeited. Typically, vesting happens monthly, quarterly, or annually, based on your plan.
Exercising Stock Options
Three years into his employment, John's stock options are vested at about 75%, and the fair market value of the options is at $20, which is above the strike price of $10. He sees this as a good opportunity to exercise his options. Exercising means that you are purchasing these options at the discounted strike price. The difference between the fair market value and the strike price, in this instance, $20 and $10, is included as ordinary income in that year.
Considerations for Exercising Options
John has a lot of things to consider, like tax implications and out-of-pocket expenses, but he continues to exercise his options. Ultimately, he realizes that he must either retain or sell his shares immediately.
Simplistic Example of Stock Options
This was a very simplistic example of the lifespan of a stock option. In actuality, there are many different factors to consider, like taxes, liquidity, goals, stock concentration, and stock price. In later videos, we will explore how we can analyze equity compensation in light of your financial plan.
Types of Equity Compensation
Many different types of equity compensation have different characteristics. Today, I'm just going to look at some of the most common ones I come across, and this is by no means a comprehensive list.
Non-Qualified Stock Options (NSOs)
I'll jump right in with non-qualified stock options. This is very similar to what we just reviewed in John's example. When your options vest, you can exercise them. After that, you would be able to sell or retain them. When you exercise, the difference between the strike price and the fair market value is taxed at ordinary income rates.
Restricted Stock Units (RSUs)
Restricted stock units are grants, so you don't have to exercise them. Once they vest, the fair market value is included as ordinary income; at that point, you have the right to retain or sell.
Stock Appreciation Rights (SARs)
These are very simple types of equity compensation. Stock appreciation rights are options where you don't have any out-of-pocket costs and don't have any tax implications at grant or vesting. When the options vest, you can receive compensation, typically in cash but sometimes in stock. At that point, you'll have some tax considerations.
Employee Stock Purchase Plans (ESPPs)
Employee Stock Purchase Plans are programs you can voluntarily enroll in to buy company stock at a discounted price. This can change from year to year based on your situation.
Conclusion
In conclusion, by understanding equity compensation, you can confidently navigate the complexities and make informed decisions on which strategies to incorporate into your financial plan. In later videos, we will dive deeper into the different equity compensation types and how to analyze them in light of your financial plan. If you want to chat, please click the link below or go to HighlandPlanning.com to schedule a free initial consultation.
Thanks for watching! See you next time.
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA.